How to create a healthy cash portfolio

Cash is king. This saying reflects the attitude that’s especially prevalent among older Singaporeans who prefer cold, hard dollars over stocks or bonds.

But what should your cash portfolio look like?

The answer depends on different situations. There is no single, “correct” number for everyone. Depending on your lifestyle needs, income, dependents, and the general economic situation, the amount of cash you should keep will vary.

This means that, as your situation changes, you should constantly re-allocate the amount of your portfolio that’s kept in cash. And it’s pretty simple if you understand the following principles.

1. Always maintain an emergency fund

An emergency fund provides liquidity in the event of a financial crisis. Without an emergency fund, even the best investment plans can go awry.

For example, say you place all your money into stocks. A few months later, you’re unexpectedly retrenched. This leaves you short on cash, so your only resort is to liquidate (sell off) the stocks you already have. If the market happens to tank at the time, and the stock values fall, you could be forced to sell at a loss.

This is why you should always keep an emergency fund. For most Singaporeans, a safe amount would be six months’ worth of expenses. This buys you time to find a new income if you’re retrenched, or to recover and get back to work if you’re injured.

Young Singaporeans, who still have working parents to count on, and no mortgage to pay, can get away with saving a little less and investing more. A 19-year old with working parents, for instance, might want to keep only three months’ worth of expenses and invest the rest.

Conversely, some Singaporeans may need to save much more. A Singaporean working purely on commissions, for example, may want to save as much as a years’ worth of expenses.

In any case, the emergency fund should never exceed one year of expenses. Doing this will create “cash drag” - the excess monies won’t yield anything, and too much of it could be eroded by inflation.

2. Plan ahead for major purchases

There will be times in your life when you have to store up more cash, and times when you should invest it instead. For the unpredictable life events, you have your emergency fund.

But for more predictable events, it’s easy to raise your cash allocation to be safe. For example, if you’re about to buy a private property in the next two to three years, you’ll want to ramp up your cash reserves. This is especially important when you are looking at a minimum down payment of five per cent for the house.

Purchasing a property is mostly built on necessity, so you are putting the cash to good use. With advanced planning towards building a larger cash reserve, you can use it to make a bigger down payment. The benefits is apparent when you shorten the loan tenure from 25 to 20 years, which effectively lowers the interest you will be paying.

3. For lay investors, hold cash when the economy is in uncertain times

Sometimes, it pays to do nothing. When the market crashes, it is better to avoid investing until the dust settles. You can consider Singapore Savings Bonds (SSBs) or fixed deposits to park your cash and wait out the chaos.

Note that some investors will do the exact opposite - when markets are volatile, there’s a good opportunity to make money. They may actually decrease their cash holdings, to purchase what they perceive as underpriced stocks, properties, etc.

This sort of market timing is dangerous to lay investors - it’s hard to guess when the market has bottomed out, so you might buy a stock only to see it fall even further (or see the company go bankrupt in the turmoil).

Unless you’re confident of your financial acumen, it’s a better idea to hold on to your cash and re-invest once things are stable.

Lay investors should consider raising their cash holdings to at least 15 per cent of their portfolio, in the midst of crashes or serious economic downturns.

4. Increase cash holdings in the retirement risk zone

The retirement risk zone refers to the five years before and after your retirement. During this time, it’s important to scale back on risky investments. Your emphasis must shift on protecting the wealth you’ve accumulated; growth becomes secondary.

Some financial advisers will suggest changing your asset allocation, to as little as 30 per cent in stocks, and 70 per cent in fixed income securities and cash. This is because if a major stock market crash occurs just before or after you retire, it could wipe out most of your funds. And given that you’re near or past retirement, you won’t have sufficient time or income to replace the losses.

In less extreme cases (e.g. you already own a range of revenue-generating assets, such as multiple paid-up properties), you may only need to raise your cash allocation to 40 or 50 per cent of your portfolio.

Note that this amount must change again, once you’re in your sixth year of retirement or beyond (you’ll still want some stock investments, at least enough to hedge against inflation).

5. You can keep less cash if you’re well-insured

If you hate cash drag, the simplest thing to do is to be well-insured. For example, with the proper insurance policy, you can get as much as 70 per cent of your income paid for a year if you’re unable to work.

Likewise, with Mortgage Reducing Term Assurance, you know your mortgage will be paid off, if you’re permanently unable to work.

Having an Integrated Shield Plan to cover your medical expenses is also a good way to reduce the cash reliance. Of course, you’ll need to factor at least $3,000 per year, given the recent requirement to co-pay at least 5% of your medical bills even if you have a full rider.

Depending on the type of insurance coverage you have, you may be able to keep no more than six months’ of expenses, and simply invest the rest.